Power Hour: Crunch Time for Corn Margins

Corn demand headwinds and major global increases in supply will put producer margins under pressure this year, which will continue for the next three to five years. Add it all up and it likely means $4-something corn at harvest this fall using the most likely set of assumptions, and $5 average corn prices during the next five years, according to Sterling Liddell, senior vice president, food and agribusiness research, Rabo AgriFinance.

While margins will remain in the black for most producers, he predicts losses for high cost corn growers. According to Rabobank calculations, U.S. corn production costs range from $4.40 to $5.20 per bushel, including land. This creates structural support for corn prices in the medium to long term, Liddell says. Even so, tighter corn margins will reduce corn acres by 5 million to 6 million in the medium term in favor of other crops and uses, he says. Liddell’s new report, "Bracing for Tightening U.S. Grain Margins," was released June 20 by Rabobank.

"Tighter margins will change farmers’ strategies beyond 2012/13 toward cost efficiency, productivity growth and tighter financial management, and away from investment and business growth," Liddell states. One change he sees some producers making as margins tighten is a shift away from continuous corn to more of a corn/soybean rotation. That will occur, Liddell believes, because production costs are often higher for continuous corn; more inputs are typically required and yields are often lower.

Producers in the driver’s seat in upcoming years will be those who keep high liquidity and working capital levels, and production costs low, giving them the flexibility to handle tighter margins. Coming off several back-to-back years of strong profits, many crop producers are in a good position to do just that. Moreover, producers who maintain a financial cushion in upcoming years will be in a position to take advantage of opportunities, such as purchasing farmland if values recede, which Liddell believes tight margins could perhaps precipitate.

Several potential factors make Liddell pause in looking at the future of corn prices. First is the potential for slower demand growth.

On ethanol, the 10% blend wall is likely to slow production at a faster pace that the Renewable Fuel Standard (RFS2) mandate. In 2007, at the time of RFS2, U.S. gasoline consumption was expected to grow from 140 billion gallons per year to more than 150 billion gallons by 2015. This growth would have easily allowed the 2015 mandated level of 15 billion gallons of ethanol to be blended without exceeding the 10% of total fuel usage or blend wall.

"However, since 2007, total motor fuel consumption in the U.S. has actually decreased to 133 billion gallons in 2012," Liddell says. There is a conflict between the mandate and the industry’s legally allowable usage. "In 2013, the 10% blend wall will fall to around 12 billion to 12.5 billion gallons, over 1 billion less than the 13.8 billion gallon mandate. As a result, ethanol derived from corn is expected to level off and stabilize near current levels of 12.9 billion gallons," he says. While both E15 and E85 have been suggested as solutions to breaking though the blend wall, Liddell does not expect either grow very rapidly over the next two to three years, due to a variety of constraints and challenges.

Additionally, Liddell believes U.S. corn exports will remain under pressure. Because of rapid global expansion in soybeans, wheat and especially corn, U.S. exports are expected to remain below historic levels until global markets require additional volume, Liddell says. "During the past 18 years, global demand for corn has grown at just 2 million tons per annum," he adds. If global demand returns to trend consumption in 2013 and export proportions returns to pre-drought levels (approximately 32% of global corn exports from the U.S.), the U.S. can expect to export just 1.3 billion bushels, as projected by USDA.

During the next three years, if the growth of rate of global corn exports reverts to the long term trend of 4 million tons per year, approximately 1.7 billion bushels would be sourced from the U.S. "Consequently, unless there is a contraction in global production capacity, we expect annual exports to struggle to regain 2009 levels of 1.9 billion bushels during the next three years."

Another important piece to the export picture, Liddell says, is just how much new competition U.S. farmers have. "Especially since 2008, expansion of corn production has been significant, increasing by 50% in Brazil and by more than 60% in Ukraine." Exports have increased substantially from both countries, he adds.